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War in Ukraine Unlikely to Deter ECB From December Rate Hike

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(Bloomberg) — The European Central Bank will look past threats to economic growth from the war in Ukraine, ending asset purchases in the summer and setting the stage for a first interest-rate increase in more than a decade in December, according to a survey of economists. 

With Russia’s invasion fanning inflation that’s already almost four times the 2% target, the ECB is expected to conclude net bond-buying in July, the poll showed. The deposit rate, currently -0.5%, is seen reaching zero in March — nearly nine years after it first turned negative.

It’s a timeline envisaged too by the world’s biggest banks: Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) both predict liftoff in December and gradual rate increases after that. Markets see a more aggressive route, betting on rates already being at zero by year-end.

The quicker policy-normalization path signaled by ECB President Christine Lagarde at the start of the year hasn’t shifted much. But the economic backdrop has. Russia’s attack has raised the specter of a euro-area recession as governments mull an energy embargo that would severely hit factories and further stoke record price growth.

Economists list the conflict and inflation as the two biggest dangers to the outlook, handing the ECB a dilemma: Action to tame prices risks choking what remains of the pandemic rebound; keeping stimulus, though, could ignite the kind of inflation spiral officials are desperate to avoid.

“The war in Ukraine has definitely brought into question the central bank’s accelerated stimulus exit,” said Claus Vistesen, chief euro-zone economist at Pantheon Macroeconomics. “But it’s also, in a way, added to it by lifting the near-term inflation outlook.”

No policy changes are expected at next week’s meeting. The format of the news conference that follows it is yet to be decided after Lagarde tested positive for Covid-19 on Thursday.

Recent remarks by officials suggest most, if not all, are on board with ending asset purchases in the summer and raising rates by year-end. But after disagreeing in March on their response to the war, differences persist over when and how quickly borrowing costs should climb.

Bundesbank chief Joachim Nagel and his Dutch counterpart, Klaas Knot, can envisage a move as soon as September. Their Belgian, Slovene and Austrian colleagues want two hikes this year.

Greece’s Yannis Stournaras, however, has urged extreme caution in using the “interest-rate weapon,” with Italy’s Ignazio Visco warning of a severely worsened outlook, and Chief Economist Philip Lane saying the ECB should be prepared to shift policy in either direction.

What Bloomberg Economics Says…

“The hawkish contingent at the ECB doesn’t seem to have had its views swayed by the war in Ukraine and currently holds the upper hand […] Our view is that the first hike will be in December, although the risks are skewed toward an earlier move.”

–David Powell, senior euro-area economist. Click here for the full report

Inflation of 7.5% that’s set to accelerate further before peaking mid-year has analysts fretting that the economy will fare worse than outlined in the ECB’s “severe” scenario. Some wonder about the odds of more aggressive tightening. 

ING’s global head of macro Carsten Brzeski, whose base case is for a first 25 basis-point hike in September, says a lengthier spell of elevated price growth could “scare the ECB so much” that it raises rates by twice that amount.

Deutsche Bank (DE:DBKGn) has also flagged the possibility of half-point moves.

Whatever path is eventually chosen, there’ll be “no strong pushback on market expectations” next week, according to HSBC Securities European economist Fabio Balboni, who says a hawkish narrative may help the ECB lower the risk of second-round effects by tempering wage demands.  

©2022 Bloomberg L.P.

War in Ukraine Unlikely to Deter ECB From December Rate Hike

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